Perhaps for the first time, India’s largest housing finance company, HDFC’s accounting practices have been questioned.
Macquarie Equity Research in a report said that HDFC has been adopting aggressive accounting practices by passing provisioning through reserves and also making adjustments for zero-coupon bonds (ZCBs) through reserves as against the profit and loss account.
Finance companies generally provide for non-performing loans (NPLs) in the profit and loss account, which results in lower profits, and hence lower earnings per share. The excess profit is then transferred to the reserve on the balance sheet of the company. However, HDFC directly provided for the (NPLs) on the balance sheet, without impacting the P&L.
As a result of its accounting policies, FY11 earnings were overstated by 38 per cent while that of FY12 is by 24 per cent. Due to these adjustments, the company’s return on equity (RoE) would have been lower by 600 basis points and 400 basis points for FY11 and FY12 respectively.
Macquarie has downgraded HDFC to ‘Underperform’ with a price target of Rs 550. The stock closed the day at Rs 644.60, down 1.6 per cent over Wednesday. Macquarie has drastically slashed HDFC’s valuation from 4 times its book value to 2 times.
Macquarie also added that HDFC benefited from the growth in loans to the real estate developers and lease rentals as compared to retail loans. Share of non-retail loans has increased from 29 per cent to 37 per cent. HDFC’s housing loan profitability has been falling structurally thus prompting the company to take on riskier loans to drive profitability.
Non-retail loans now account for 65 per cent of the company’s profit according to the report.
Regulatory issues like higher provisioning requirements, banning pre-payment charges and re-aligning old and new customer rates can have an impact on HDFC’s profitability says the research report.